Democratic tax plan would clip charitable deduction for few taxpayers

View full sizeRep. Phil Barnhart, D-Eugene, chair of the House Revenue Committee, hopes to raise $275 million for schools and other services with new tax provisions in House Bill 2456.Michael Lloyd/The Oregonian

SALEM – A component of a Democratic plan to raise $275 million in tax revenue over the next two years is under fire from leaders of charities and nonprofits who say the plan would reduce the incentive for Oregonians to make charitable contributions.

Any major change in charitable giving is a big deal to nonprofits, which rely on individual donations for 13 percent of their operating budgets on average nationwide.

But it's unclear whether they'd see any noticeable drop in donations under the proposal. The 10,000 taxpayers who would partially lose access to income tax deductions under House Bill 2456 make up less than 1 percent of tax filings in Oregon. And the $400,000 average income of those affected would likely clear the way for them to deduct most gifts from their federal taxes.

The details lie in the delicate dance that Oregon's income tax plays with the rules of the IRS.

"I think that once the Oregon charities and nonprofits understand what the bill actually does, they'll be a lot more comfortable with it," said Rep. Phil Barnhart, D-Eugene, chair of the House Revenue Committee.

Under Oregon law, for every $1 taxpayers donate to charity, they can deduct $1 from their taxable income. The same rules apply at the federal level.

That federal deduction creates a powerful incentive. For high-earners who pay the top income tax rate of 39.6 percent, claiming a $10,000 donation will save $3,960 in tax.

Oregon tax proposal

House Bill 2456 would change deduction rules for some Oregon taxpayers. A few highlights:

Taxpayers with taxable incomes under $125,000 would not be affected.

Deductions for taxpayers with taxable income over $125,000 would be limited based on how much they made over the income threshold.

On roughly 10,000 tax returns -- including individual and joint filers, with an average incomes of $300,000 -- itemized deductions would effectively be eliminated. They would take the standard deduction of $2,080 for an individual or $4,160 for joint filers -- the same deduction available to those who don't itemize.

The same math applies in Oregon on a smaller scale. At the top state tax rate of 9.9 percent, a $10,000 donation will save $990 in state tax.

"The federal one is much more important to almost everybody because it's so much bigger of a tax effect," Barnhart said.

Wednesday, during a second day of hearings on the bill, House Revenue Committee members heard testimony from nonprofits that considered the measure tantamount to eliminating the charitable deduction and advocates for new taxes who said the federal rule that is the model for the bill hadn't had an impact.

Both sides are partially right.

The Democrats' charitable proposal is based on an obscure federal tax provision called "Pease."

Named after its author, U.S. Rep. Donald Pease, D-Ohio, Pease was enacted in 1990 as one of two so-called "stealth" tax increases. It's often called a limit on tax deductions, but that's not really what it does.

Instead, the richer you get, the fewer deductions you can claim. But there's an escape clause: Pease can only reduce deductions by up to 80 percent.

That means, for the most part, no matter how rich you get, there's always something left to deduct and there's always an incentive to donate to a charity.

Pease was repealed in 2010, but was reinstated as part of the tax deal that averted the "fiscal cliff" in January.

But there's a catch. Pease cuts into the bottom line for about 40,000 taxpayers nationwide, who have relatively low itemized deductions. Most of those taxpayers live in states without income tax (which the feds allow as a deduction), such as Washington.

The provision of House Bill 2456 modeled after Pease uses different math, but achieves the same goal: the more you make over $125,000, the more your itemized deductions are reduced.

For most taxpayers who would be subject to the bill, the incentive for charitable giving would remain. But roughly 10,000 taxpayers would see their itemized deductions stripped by the surcharge.

For those taxpayers, Bakija said, the incentive for charitable giving would be gone.

Since those 10,000 taxpayers would still be able to reap the benefit of the federal deduction, they'd have plenty of reason to donate, Sheketoff said.

"If they're charitable, those 10,000 aren't making decisions based on their tax rates," Sheketoff said. "Washington state has a heck of a lot of philanthropy and it has no incentive in the tax code. The rates are what matter."